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Find out how these businesses work, what kinds of yields and growth investors can expect for the long term, some of the most exciting opportunities coming up for these two, and more. If you want to learn about the other Brookfield companies, you can go back to last week's episode for a deep dive on Brookfield Asset Management (NYSE:BAM), Property Partners (NASDAQ:BPY), and Business Partners (NYSE:BBU).

A full transcript follows the video.

This video was recorded on Feb. 21, 2019.

Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, February 21st, and this is part two of our discussion on the Brookfield family of companies. I'm your host, Nick Sciple, and today I'm joined by Motley Fool contributor Matt DiLallo via Skype. How are you doing, Matt?

First, let's start off talking about Brookfield Infrastructure Partners. This is a company that went public in 2008, came out from the Brookfield Asset Management parent company. It's one of the largest owners and operators of infrastructure assets in the world, as the name Brookfield Infrastructure Partners might tell you. Matt, what type of infrastructure does Brookfield Infrastructure Partners invest in? Where in the world are they allocating their capital?

DiLallo: For those who aren't familiar with what infrastructure is, it's the underlying structure of the economy, anything from railroads to pipelines to electricity poles. It's those things that we tend not to see unless they cause problems. Brookfield really casts a wide net. They have four businesses. One's utilities, and that's distributing electricity, natural gas to customers. Then they have energy, which is pipelines; natural gas storage; district energy, which is in cities where you'll have a couple of buildings connected, and they'll have a connected energy system. Then they have transportation, which is ports, rail, and toll roads. Finally we've got data infrastructure. That's your cell towers and your data centers. Really a broad range, and they're invested all over the world.

Sciple: Yeah. What's great about all these infrastructure assets is that they really put out predictable cash flows. Any of these, you're getting capital based on the volume of use that your customers are using. For a pipeline, for example, the more natural gas or oil that flows through your pipeline, the more you get paid. For something like natural gas, which we've discussed on this show, you have to get the gas to the market, so you're going to get continual cash flows. It makes their cash flows really predictable, which is great for a business like this that tends to lean more toward an income type of strategy.

Can you talk about what those steady cash flows really do when it comes to the reliability of the dividend and the way you can really count on that as an investor?

DiLallo: Because there's long-term contracts, especially in the natural gas pipelines, Brookfield knows what's going to come in. Even in some of the more economically sensitive businesses like a toll road, where they're dependent on volumes of cars passing through, which will decline when there's a recession, there's still a predictability in that. They have that predictability of cash flow from those.

They also have, as you mentioned, the volume growth. As the economy grows, more cars will go on their toll roads, more oil or natural gas will flow through their pipelines. So then, there's that GDP linkage. You'll see the income go up.

That really gives them a solid base of cash flow that they can pay out in their distribution. They target about 70% to pay out. That's a pretty conservative rate. That gives them some money to invest in some expansion projects. It's a really good way to play infrastructure, especially if you're an income-focused investor.

Sciple: Yeah. They have a really strong track record. From what I've seen, they hold their average investment for about eight years and they generate an internal rate of return above 20% on average, which is a really strong rate of return. When you think about the way the business grows, it's predominantly through acquisitions, as we mentioned. Their cash flows for the infrastructure that they own are going to be pretty stable over time. They're going to grow by buying an asset at a reasonable price, holding it for their holding period, then selling it for more than they bought it for, then reinvesting that capital, rinse and repeat. Is that a fair characterization of the way the business tends to operate?

DiLallo: Yeah, that's exactly what they're trying to do. Because they're 10 years old, a lot of the assets that they initially had, they sold them out. They're entering another period where they're starting to sell assets that they've held for several years. They had an electricity distribution business in Chile that they sold last year for $1.1 billion. They had held it for years and years and years, but it had gotten to the point where they'd really maximized all the value out of it. It was only going to grow by about 1% to 2% a year based on the inflation that they were expecting, so they topped out. It was a good time to sell and then take that cash, and I think they're up to six or seven acquisitions that they have in the pipeline to replace that. That's their business model. Maximize it, then we'll buy something else that's earlier in the business cycle.

Sciple: They've changed their strategy over the past year or so. In the past they had to rely a little bit more on debt to fund their acquisitions, whereas management has really been open about talking about how they want to transition from that model more toward self-funding growth, as you mentioned, by recycling their assets through the pipeline. As we look into the results from 2018, there was a go-forward year when it came to shifting that strategy. Shares were down about 1% over the year. When you adjust funds from operations to a per-unit basis, they were basically flat.

Can you talk about how the company is absorbing or adjusting to this change in the way that they fund their acquisitions, and how investors should think about that going forward into 2019?

DiLallo: Brookfield, you mentioned that they used debt and equity. Part of what they're trying to get away from is issuing equity because that dilutes investors. The market just hasn't been as open to new equity issuances from income-type entities. MLPs have been hit very, very hard by the energy thing. A lot of it has to do with rising interest rates. There just isn't the investor interest in buying equities. Brookfield used to be able to issue equity no problem to make acquisitions. But because they're so value focused, they looked at the value of their equity, and it wasn't appealing to issue it anymore. However, the value of their assets, to others, they could sell that for a premium and then reinvest that. That's how they've decided to shift.

Now, that hurt them last year. As you mentioned, on a per-unit basis, funds from operation barely budged. However, that was almost entirely due to selling an asset which they're subsequently reinvesting into several businesses that should grow FFO by about 20% going forward. It's kind of like they're literally shifting gears. They slowed down so that they can really accelerate with this new business model. That should make them less susceptible to market crashes like we saw back in December. They had a deal that they wanted to fund that wouldn't have been as attractive if they had to do it as the market was selling off.

Sciple: We're talking about how the business has transitioned. They're really starting to recycle their assets through. Let's talk about where Brookfield is really seeing opportunities to redeploy its capital in infrastructure. One of the places they really called out as a significant opportunity for them, you mentioned MLPs and pipelines, that's a place that Brookfield really finds attractive. Back in October, they closed their acquisition of Enbridge's Western Canadian natural gas gathering and processing business. That was a large acquisition that really increased their position in the natural gas pipeline business. Can you talk about that acquisition? And then, more broadly, how Brookfield looks at the gas distribution pipeline business as an opportunity for them to grow?

DiLallo: As you hinted at, the energy market downturn in recent years has really made it hard for MLPs and pipeline companies like Enbridge to sell equity to fund growth. They've turned to selling assets. Brookfield had an opportunity to buy one of the best gathering and processing businesses out in Western Canada. What gathering and processing is, basically they take the natural gas from the wellhead and then they separate the natural gas liquids from the gas. They make money based on fees, the producers pay them fees to do this. Very stable cash flow, lots of growth out there. Shale plays come to mind -- we don't know it much here in the States, but it's a very fast-growing shale play out in Canada, lots of natural gas liquids. There's a lot of growth opportunity out there as Canada finally starts exporting natural gas in a couple of years and Shell finishes their plant and the natural gas liquids, they can use those. They make petrochemicals and other things with those. It's an opportunity to participate in that growth out there.

More broadly, as you mentioned, investors aren't buying MLPs and pipelines anymore. With interest rates rising, there's other competition like CDs. And then the market for MLPs just tanked. There's investor fear of investing in those types of assets. It's opened the door for Brookfield to start looking at hunting for new deals. I wouldn't be surprised if they have a couple more this year. It's a huge market opportunity. They've said it's about $150 billion in the next couple of years just from asset acquisitions, and then helping MLPs recapitalize. Lots of opportunities for them out there.

Sciple: Brookfield has positioned their balance sheet to put them in a position to really start deploying capital throughout the next year. Management has mentioned over the past year, they've raised $800 million in debt and preferred equity as well as refinanced $1.5 billion in debt to put them in a position where management has said, quote, they "don't have any maturities to worry about for the next five years." They have $3.5 billion in liquidity available right now in addition to whatever assets sales they may undergo to raise more capital and redeploy that.

As you look forward into the growth opportunities for Brookfield, as I mentioned, they have a balance sheet that puts them in a position to redeploy their capital. How bullish are you on the growth opportunities for Brookfield Infrastructure Partners, looking out over the next few years?

DiLallo: I'm really excited about them. What's exciting about them, what we haven't talked about yet, is Brookfield doesn't bake acquisitions into their growth forecasts. They think they can grow their funds from operations by 6-9% per year, and that's all organic. That's volume growing through their ports, it's inflation-linked contracts in their natural gas pipelines. Then there's this third aspect of expansion projects. They have a bunch of expansion projects all around the world. They're working with Kinder Morgan on a natural gas pipeline in the Gulf Coast. They've got some projects on their cell towers out in France. They have a lot of these organic growth projects. You have those, that should give you that steady growth in the next couple of years, and then you have the added kicker of this value uplift as they sell assets. You mentioned the electricity transmission business. They thought that was only going to grow about 2-3% a year, so they sell that and buy six businesses that should grow by mid-single-digit rates. So, you're getting a faster organic growth rate from that, plus the uplift in the earnings from selling one business and buying these other ones that they're getting for a better price. I think it could do maybe a double-digit total return when you add in the dividend going forward. You're not talking about doubling in the next year or so, but you're talking about, if you hold this for several years, you should do very well.

Sciple: You're going to have more cash after holding Brookfield Infrastructure Partners than you did before you bought into the company, and I think that's what you're looking for. An investment in Brookfield can reliably give you that, and has a track record to prove that.

OK, Matt, let's talk a little bit about Brookfield Renewable Partners. This is another Brookfield subsidiary, launched in 2011. As the name may indicate, they invest in renewable energy assets. Can you talk a little bit about how the Brookfield Renewable business is structured and how they make money?

DiLallo: Brookfield's core businesses is hydro power. That's what their foundation is. They've gotten into wind, and more recently they've added some solar. They acquired a stake in TerraForm Power and TerraForm Global, which are two renewable companies focused on wind and solar. Now they have that full renewable platform.

What's different about Brookfield, though, from a utility, is that they sell this power to utilities under long-term contracts. They'll generate steady cash flow as electricity is generated out of their hydro power. They're getting paid a steady rate. That insulates them from power prices, which can fluctuate based on demand. You've got that steady cash flow coming in. That's what makes them an interesting way to play renewables.

Sciple: You mentioned they're mostly hydro power. About three-quarters of Brookfield Renewable's assets are allocated toward hydroelectric power. They really like the opportunity there because it has a really long, useful life. Once you get the dam in place to generate power, the capital costs to maintain it are relatively low.

Another thing that they mentioned, which I find interesting, and it ties into some discussions we've had previously on the show, is that they're able to match power supply with demand. You talk about solar and wind, there can be some issues with demand for power not lining up to when the sun is shining or the wind's blowing. But when it comes to hydro power, you can really regulate that because you can just stop water flowing through the dam to line things up with demand.

They've really focused in hydro for a long period of time, but over the past few years, as you mentioned, they've started moving more into wind and solar. Management has said the reason they stayed away from wind and solar for the longest time was because the economics didn't make sense, there wasn't a clear path to profitability to acquiring these assets. However, in the past few years, as prices for these systems have started to come down, they've really started to push into those assets. That's another case of indicating the way Brookfield thinks about investing in assets. It's not "Demand for this is going to grow over time." It's "How can I make a cash return on this investment?"

We talked about how this TerraForm investment has really moved them into solar energy in a meaningful way where they hadn't been before. This TerraForm acquisition lines up with those other acquisitions we talked about in part one last week. They bought TerraForm Power out of bankruptcy from SunEdison. Can you talk about how that transaction shook out and what advantages that gave to Brookfield, being able to buy a distressed asset like TerraForm?

DiLallo: It lines up with Brookfield Asset Management's overarching goals to buy for value. They'll target something, and they'll keep an eye out until they see something of value. But it also needs to be substantial enough to provide them a platform.

They saw an opportunity when SunEdison went bankrupt to take over their yieldcos, so they pounced on that opportunity and they took TerraForm Global private. They have a sizable stake in TerraForm Power. That gives them that platform in wind and solar that they can expand. They've been able to help TerraForm Power expand significantly since they bought this stake. They bought a Spanish wind and solar company last year. That expanded them into Western Europe. That's their goal going forward, is to be able to expand this business.

Sciple: I saw, from that acquisition, they doubled annualized cash flows for TerraForm Power. It really helped them with capital structure. They were able to help them get out of some unfavorable financing covenants and put them in a position to generate stable cash flows over time. It's just another example of how, when Brookfield buys these assets, they really know how to position them well not just for the value that they have when they acquired them, but what steps they can take after they acquire the asset to increase its value even further.

Another thing they're moving into, another thing I found interesting, they're moving into energy storage. When you talk about renewable energy, I mentioned lining up supply of energy with demand, energy storage helps with that when you're looking at wind and solar. Do you think that is a significant opportunity for Brookfield? Or is that more peripheral to the other assets they own? How should we think about the energy storage part of their investments?

DiLallo: I do think that it's going to be important for renewable growth overall to be able to have storage that's cheap enough to make it economically viable. One company that's really on the forefront of that is NextEra Energy. They actually just signed a deal with a utility to do wind, solar, and storage at the same location.

Sciple: Another thing that I really found interesting about what Brookfield Renewable is doing is they're expanding their investments into energy storage. We've talked about on this show in the past, and it relates to what I said earlier on the hydroelectric assets -- when it comes to the ability to line up renewable energy supply with demand for energy production assets like wind and solar that only produce power when the sun is out or the wind is blowing. Do you see the energy storage opportunity as one of significance for Brookfield Renewable? How should investors think about that when they think about this investment?

DiLallo: I do think it's a significant step for them. As you mentioned, the intermittency of renewables has been a drag on growth. It's been something that those who are against it have pointed out. We need this baseline power. It does take companies to invest in these and to add them now, so it's good to see them making these investments.

I do think we're going to see a lot more of that going forward, not only from Brookfield, but from others in the industry. NextEra Energy is one that has been on the forefront of energy storage. They recently signed an interesting deal with a utility out on the West Coast where they're building a huge energy facility that will include wind, solar, and storage. If the sun's not shining, it'll probably be windy; and if it's not windy and the sun's not shining, they'll have that energy storage component. I think that's going to be something that we'll see a lot more of, where they're going to add in this energy storage. NextEra Energy's CEO was clear that the way the cost curve has come, the way technologies have improved -- I'm paraphrasing his quote because I don't have it offhand -- within a decade, when you add in energy storage to wind and solar, and this is without government incentives, it should be lower than all forms of power other than natural gas on a high-efficiency system. That was a bold statement, but it's definitely the direction that the industry is heading in. That's really exciting, climate change worries, and just getting rid of emissions in general, to see that happening. It's exciting.

​Sciple: Yeah, and for a company like Brookfield, it shows that there's opportunities to make profits on these investments today, which is why we're seeing them start to move into the space, particularly with wind and solar.

Let's talk a little bit about Brookfield Renewable's yield. That's one of the most attractive parts about this business, it yields almost 7%. When you talk about the energy assets they have, their cash flows are really predictable because, particularly with renewable energy, the sun is going to keep coming out, the wind's going to keep blowing, and the rivers are going to keep flowing to power these hydro assets. When you look at this dividend, how attractive is it to you as an investor? What prospects might we have for it to continue to increase over time?

DiLallo: I'm very much of an income-focused investor. Companies that increase their dividends, the data shows that they tend to outperform all other companies. So any time I see a company that pays an attractive dividend, that they have clear ways to be able to increase it, that's going to catch my eye. Then you add in the renewables and it just makes this such an attractive long-term holding for any investor. You're going to need income eventually. Whether you're quite a ways away from retirement like I am, still, I can reinvest that into other opportunities.

You're looking at an investment that's going to pay very steady cash flow, it's going to increase. They just raised it to 5% for this coming year. They have clear ways to be able to continue to raise it because they can sign up higher-price contracts for the power as contracts expire, and they're developing new wind and hydro projects and solar around the world. And then acquisitions. You have three or four growth drivers of this company that are going to take that dividend up and up and up.

Sciple: Yeah, and if you look out over time, throughout its history as a business, it's delivered an annual total return -- taking into account the dividend -- of 15% over time. Really, if you can give me a 15% compounded annual return, over time that's going to compound your wealth in a significant way.

Let's talk a little bit about Brookfield Renewable's balance sheet. We got another question from listener Noel Sayers about that. He's been staying away from Brookfield Renewable both because he sees them as having a heavy debt load on their balance sheet as well as, as we mentioned on part one of this Brookfield discussion that you can listen to last week, he's concerned about the fees that Brookfield Asset Management charges to the Brookfield Renewable subsidiary. We already covered the question about the management fees. You can go back and listen to our episode last week if you want to hear about that. When you look at Brookfield Renewable's balance sheet, do you have concerns over the level of debt that they are carrying today?

DiLallo: I don't because Brookfield structures its debt to investment-grade ratings. They also do it typically on an asset level or on the business level. They own several operating businesses. We mentioned TerraForm Power, they own a big stake in that. You factor in TerraForm's debt. Then, they own a business out in Ireland. They own one in, I believe, Colombia. The debt is at those business levels, those asset levels. It's nonrecourse to Brookfield, which means if one of those businesses goes bankrupt, they would restructure that business and it wouldn't have any impact on Brookfield. You have that debt down at those levels. It's all investment grade, how they structure it. In this case, Brookfield looks for three times EBITDA. For a business that's generating very stable cash flow, that's pretty low.

So I'm not worried about them. I actually like the fact that they have an investment-grade balance sheet. For me, that's a stamp of approval, to say that, and somebody that's a lot smarter than me on credit believes that this is solid from a credit standpoint. What an investment-grade balance sheet means is that when a downturn comes, this is a company that should still be able to pay its bills. So, that's something that I'm very comfortable with.

Sciple: It also allows Brookfield to raise debt at lower interest rates. When you talk about the ability that they have to allocate their capital in a way to drive attractive returns, if you can, say, raise debt at 3-4% and then invest that capital at 7-8%, that's a really good position to be in as an asset-allocating business.

When we think about where Brookfield Renewable is going to be going forward, their opportunities to continue expanding over time, what opportunities do you see there for the business? How excited are you about the opportunities in renewables both for Brookfield and in general across the broader market?

DiLallo: It was a third quarter as a shareholder letter that Brookfield put out -- and I highly recommend reading any of Brookfield's shareholder letters. There's always some nugget in there that's just mind-blowing. This one in particular, the CEO of Brookfield Renewable said that it's a $10 trillion opportunity in renewables to basically wean the global economy off of fossil fuels. And that's only in the markets that Brookfield operates in, which are big markets, the United States, Canada, those big, developed countries. But that just shows you the size of the opportunity for them to invest capital. With them investing it at a value basis, there's just going to be really good opportunities for them. They'll look, they'll wait for situations like a TerraForm, where they can scoop it up for really good valuations. I'm very excited about what they can do. They think they can invest probably $700 million a year on just acquisitions, and that'll grow over time as their cash flow grows. It's one of the most exciting, for me, renewables out there.

Sciple: Yeah, because when you look at renewables, the way they're positioned to grow over time, as I've continued to mention, the ability of Brookfield executives to allocate capital in a very prudent way that's going to generate returns over time, it's an attractive way to get exposure to renewables in a space that sometimes can be difficult to find opportunities that give you a strong risk-adjusted return. When you look at solar panel makers over time, they've been tough companies to own for investors. Brookfield gives you a way to get exposure to those really important trends in a way that you can sleep at night, which I find really attractive as an investor. What do you think, Matt?

DiLallo: Absolutely! I've been burned, to use a pun, on solar panel makers several times. This is one of the few times I've actually made money on renewables. I'm excited for that to continue. [laughs]

Sciple: Before we go away, over these last two episodes, we've discussed Brookfield Asset Management, Brookfield Property Partners, Business Partners, Infrastructure, the entire family of Brookfield companies. As you look out at this potential basket of investments, are there any of them that particularly stand out to you as, "If I only had a certain amount of capital to invest, this would be the one that I would invest in"? How do you think about choosing between this entire family of businesses to invest in?

DiLallo: If I was an investor just starting out, I would go with Brookfield Asset Management for two reasons. One, you get the whole pie. You get the renewables, you get the infrastructure, you get the property. You also don't have to deal with those Schedule K-1s that we mentioned in last week's episode. It's a much easier investment for somebody to make in a retirement account, for example. That's where I would start. But, if somebody wanted specifically exposure to renewables or property, then I would look more at the subsidiaries, especially if you're more income-focused. But if you're younger and looking for a retirement option, Brookfield Asset Management would be the top one I'd buy.

Sciple: Awesome, Matt! I'd agree with you there. The simplicity from a tax point of view, the exposure across all the family of businesses, I really find attractive. I will say, Brookfield Renewable is something that does appear very attractive to me. I like the way they've allocated assets. You just mentioned how big the total market opportunity is. But you really can't go wrong with anybody in this family of companies. They check a lot of the boxes that you're looking for as an investor. Definitely a company that our listeners should pay attention to, both the parent as well as all the subsidiaries.

Matt, I want to thank you for coming on these past couple of episodes! I hope we shared some valuable information for our listeners!

DiLallo: Thanks for having me!

Sciple: Awesome, Matt! As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Rick Engdahl and Dan Boyd for their work behind the glass. For Matt DiLallo, I'm Nick Sciple. Thanks for listening and Fool on!

Author

Matthew is a Senior Energy and Materials Specialist with The Motley Fool. He graduated from the Liberty University with a degree in Biblical Studies and a Masters of Business Administration. You can follow him on Twitter for the latest news and analysis of the energy and materials industries: Follow @matthewdilallo